Chapter 7, Problem 8C

Analyzing Starbucks’s Inventory Disclosures Obtain Starbucks’s 2017 annual report either using the “Investor Relations” portion of its web site (do a Web search for Starbucks investor relations) or go to http://www.sec.gov and click “Search for company filings” under “Filings and Forms (EDGAR).”

Required:

1. 1. What is the primary cost flow assumption that Starbucks uses: Discuss how the amounts reported under this assumption compare to amounts reported under alternative cost flow assumptions. Explain why you think Starbucks selected this method.
2. 2. What type of inventory system—perpetual or periodic—do you think Starbucks uses?
3. 3. Does Starbucks have any purchase commitments? If so, are they included in inventory?
4. 4. Assume ending inventory for 2016 was $1,306.4 million. Compute the inventory turnover ratio for 2018 and 2017. What is your evaluation of the difference? (Round your answer to two decimal places.)
5. 5. Recreate summary journal entries to record the transactions that affected inventory during 2018. (Assume all inventory purchases were on account.)

To determine

Determine the primary cost flow assumption used by Corporation S. Explain the manner in which the amounts reported under this cost flow assumption are different under alternative cost flow assumptions and also explain the reasons behind the selection of the cost flow assumption by Corporation S.

Explanation of Solution

Inventory cost flow assumptions: These are the methods used by the companies to compute the cost assigned to inventory from the time inventory is bought to the time inventory is sold.

Corporation S primarily uses a moving average cost flow assumption. Since, the prices of the goods are based on an average of the goods available for sale. The moving average cost flow assumption yields amounts for ending inventory and cost of goods sold that fall between the reported amounts produced by the other cost flow assumptions. Average cost may have been selected due to the fluctuating costs that often exist in the market for coffee beans.

To determine

Identify the type of inventory system used by Corporation S.

Explanation of Solution

Perpetual inventory system: The method or system of maintaining, recording, and adjusting the inventory perpetually throughout the year, is referred to as perpetual inventory system.

Corporation S uses perpetual inventory system. In its Notes to financial statements (Note 1), Corporation S reports that it uses moving average cost flow assumption which would be consistent with a perpetual inventory system.

To determine

Identify whether Corporation S has purchase commitments and whether it is included in inventory or not.

Explanation of Solution

Purchase obligation: The situation where a company commits to purchase goods on a future date at a fixed price is referred to as the purchase obligation.

Corporation S has purchase commitments relating to green coffee of $1.196 billion, which consists of $860 million of fixed-price contracts and an estimated $336 million of price-to-be-fixed contracts (see Note 5). The purchase commitments of Corporation S are not included in its inventory.

To determine

Compute the inventory turnover ratio for 2018 and 2017.

Explanation of Solution

Inventory turnover ratio: This is a financial measure that is used to evaluate as to how many times a company sells or uses its inventory during an accounting period. It is calculated by using the following formula:

  $\text{Inventory turnover = }\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Compute the inventory turnover ratio for 2018 and 2017:

Formula	2018 Amounts in million	2017 Amounts in million
Inventory turnover: $\frac{\text{Cost of goods sold}}{\text{Average inventory}}$	$\begin{array}{l}=\frac{\text{\$ 9,038}\text{.2 }}{\$1,371.25}\\ =6.59\text{ times}\end{array}$	$\begin{array}{l}=\frac{\text{\$ 8,511}\text{.1 }}{\$1,342.45}\\ =6.34\text{ times}\end{array}$
Average inventory: $\frac{\left(\begin{array}{l}\text{Beginning}\\ \text{ inventory}\end{array}\right)+\left(\begin{array}{l}\text{Ending }\\ \text{inventory}\end{array}\right)}{\text{2}}$	$\begin{array}{l}=\frac{\text{\$1,364}\text{.0 }+\text{\$1,378}\text{.5 }}{\text{2}}\\ =\frac{\text{\$}2,742.5}{\text{2}}\\ =\$1,371.25\end{array}$	$\begin{array}{l}=\frac{\text{\$1,378}\text{.5}+\text{\$1,306}\text{.4 }}{\text{2}}\\ =\frac{\text{\$}2,684.9}{\text{2}}\\ =\$1,342.45\end{array}$

Table (1)

Thus, the inventory turnover of Corporation S for 2018 and 2017 are 6.59 times and 6.34 times respectively.

To determine

Prepare summary journal entries to record the transactions that affected the inventory during the year.

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Prepare journal to record the entry for income tax of Company N at the end of 2019:

Date	Account title and Explanation	Post ref.	Amount (in million)
			Debit	Credit
2018
December 31	Inventory (1)		$9,023.7
	Accounts payable			$9,023.7
	(To record the purchase of inventory)
	Cost of goods sold		$9,038.2
	Inventory			$9,038.2
	(To record the cost of goods sold)

Table (2)

To record the purchase of inventory:

• Inventory is an asset and it is increased. Thus, it is debited.
• Accounts Payable is a liability and it is increased. Thus, it is credited.

To record the summary entry for inventory:

• Cost of goods sold is expense and it is increased. Thus, it is debited.
• Inventory is an asset and it is decreased. Thus, it is credited.

Working note 1: Compute the net purchases that affected the inventory:

$\begin{array}{c}\text{Purchases}=\left(\begin{array}{l}\text{Cost of }\\ \text{goods sold}\end{array}\right)+\left(\begin{array}{l}\text{Ending }\\ \text{inventory}\end{array}\right)-\left(\begin{array}{l}\text{Beginning }\\ \text{inventory}\end{array}\right)\\ =\$9,038.2\text{ million}+\$1,364.0\text{ million}-\$1,378.5\text{ million}\\ \text{=\$10,402}\text{.2 million}-\$1,378.5\text{ million}\\ \text{=\$9,023}\text{.7 million}\end{array}$